Dear daughter,
The rule of 4% is a rule that some financial planners use to tell you how much you need to save and invest to have a comfortable retirement.
The rule state that if you withdraw 4% from your portfolio each year, your money won’t be depleted in 30 years or more. In other words, you can use 4% of your investment returns every year without worrying that you are going to deplete your investments.
This rule is meant for people that are planning to retire at age 65. Also, it aims to keep your money for 30 years or more.
My problem with this rule is that financial planners will ask you a funny question: How long are you planning to live after retirement?
I mean, really?
Yes, my daughter, they use the years that you still have before, the years you are planning to live after retirement, and historical data about the stock market returns. Then they will tell you how much you need to start saving and investing for you to be able to live 30 years after retirement with a certain amount per year.
How do I use the 4% rule?
In my case, I don’t try to guess how many years I’ll live after retirement. Despite it, the 4% rule can be helpful because the number is based on historical data.
Therefore, there is a high probability that those numbers will be enough for you.
However, in the case of the stock market, investors know that past performance is not an indicator of future performance.
Also, the 4% rule does not consider lifestyle changes. Which can definitely happen as one gets older.
So, I use the part that is useful for me.
First, because I have a monthly budget, I know how much money I spend in a month, and therefore in a year. Let’s call that number Y.
Then, I adjust Y using the historical inflation rate, which gives me $X, my target after retirement.
Considering the 4% rule, $X should be 4% of the total amount I have invested (my portfolio).
This means, that if I get more than a 4% return on investment each year, my portfolio will grow instead of decreasing. What a great thing to have in retirement!
That’s my first goal! Having a portfolio that the 4% is $X.
Once I achieve that, I can consider myself financially free. Why, because at that moment, I’ll work if I want, not because I must. This can happen because money can work hard for you, instead of you working hard for money.
When I achieve that point, I’ll definitely keep investing. The more you have invested, the more you will be able to use without depleting your portfolio. That is my “great goal”! Being able to do what I want, without being worried about money.
Now dear daughter, what is your number $X?
Love you, Dad.